Thursday, May 4, 2023

The Cryptocurrency Use Case

Paul Le Roux
By Farantgh - Own work
A frequently-asked question about cryptocurrencies is "do they have an actual use case apart from speculation?" Jemima Kelly's Using crypto for crime is not a bug — it’s an industry feature starts:
One of the (many) times I have been heckled during a panel on crypto was when I argued that it shouldn’t be thought of as money. The only reason to use it other than for speculation, I said, was to buy drugs on the internet. This was a preposterous idea, the heckler retorted; crypto is used for so much more than that.
and ends:
So in a funny way, my heckler was right: crypto isn’t just used for speculating on and buying drugs on the internet: it’s used for much murkier criminal activities, too.
Below the fold I discuss the details of the "murkier criminal activities".

Kelley riffs on two main sources. First, the CFTC's lawsuit against Binance:
the Commodity Futures Trading Commission alleges that Binance’s former chief compliance officer said of certain Binance customers: “Like come on. They are here for crime.” The exchange’s money laundering reporting officer, according to the CFTC, agreed: “We see the bad, but we close 2 eyes.”
Second, Chainalysis' fascinating 109-page Crypto Crime Report. This reveals that:
Despite the market downturn, illicit transaction volume rose for the second consecutive year, hitting an all-time high of $20.6 billion. We have to stress that this is a lower bound estimate — our measure of illicit transaction volume is sure to grow over time as we identify new addresses associated with illicit activity, and we have to keep in mind that this figure doesn’t capture proceeds from non-crypto native crime (e.g. conventional drug trafficking involving cryptocurrency as a mode of payment). For example, last year we published that we found $14 billion in illicit activity in 2021 — we’ve now raised that figure to $18 billion, mostly due to the discovery of new crypto scams.
Chainalysis notes a major change in the profile:
It’s also worth keeping in mind that 43% of 2022’s illicit transaction volume came from activity associated with sanctioned entities, in a year when OFAC launched some of its most ambitious and difficult-to-enforce crypto sanctions yet. Crypto exchange Garantex, which accounted for the majority of sanctions-related transaction volume last year, is a great example. OFAC sanctioned Garantex in April 2022, but as a Russia-based business, the exchange has been able to continue operating with impunity. Transactions associated with Garantex or any other sanctioned crypto service represent, at the very least, substantial compliance risk for businesses that are subject to U.S. jurisdiction, including fines and potential criminal charges.
And these caveats:
  • These are lower bound estimates that will likely rise over time as additional illicit activity is discovered.
  • This does not include off-chain criminal activity where proceeds may have been moved into crypto for laundering, though that activity can still be traced.
  • This does not include volumes associated with centralized services that collapsed in 2022, some of which are facing charges of fraud, given lack of off-chain insights.
  • Funds received by sanctioned entity Garantex accounts for much of 2022’s illicit volume. While most of that activity is likely Russian users using a Russian exchange, most compliance professionals treat this as illicit activity.
Kelly writes:
Crypto enthusiasts argue that it’s wrong to claim that it enables crime because the technology itself is “neutral” so cannot be blamed for any illicit activity. But this simply isn’t true: crypto was designed as a censorship-resistant payment mechanism that operates outside the traditional financial system and beyond the remit of regulators. Crypto transactions are not subjected to the same fraud detection, anti-money laundering or suspicious activity checks that traditional ones are. Operating outside the system is its very raison d’ĂȘtre.
Why was Bitcoin, the first successful cryptocurrency "designed as a censorship-resistant payment mechanism"? It is often and credibly said that this was because it emerged from the cypherpunk mileu; as far as Bitcoin was the culmination of long histories of academic research and digital currency experiments this is true. Crime was a raison d’ĂȘtre of some of Bitcoin's predecessors, such as Liberty Reserve (2006-2013). But in By The Claw, Satoshi Is Revealed Michel de Cryptadamus argues that criminality was the primary motivation for the design of Bitcoin.

The identity of "Satoshi Nakamoto" has inspired endless speculation, not to mention lawsuits. One person who was undoubtedly close to Nakamoto was the late Hal Finney; the recipient of the first Bitcoin transaction. He died of ALS on 28th 2014. On 13th December 2022 someone sent Martin Shkreli a message signed with the private key for the wallet Hal Finney used in that first transaction. The signature is valid, and the message contents are "This Transaction was made by Paul Leroux to Hal Finney on January 12, 2009". This raises a number of questions, apart from "why Martin Shrekli?"

First, who has Hal Finney's keys? Cryptadamus writes:
Hal Finney died of Lou Gehrig’s disease (ALS) after a long illness. He knew he was going to die for quite a long time before he finally actually died. I have read in a few places that Hal made it known he had made arrangements to transfer his keys to his heirs.
Hal Finney’s wife reactivated Hal’s Twitter account 3 days after this message was sent. It had been dormant for 12 years. At a minimum this is very interesting timing.
The idea that Hal Finney's wife might know who was the sender of the first transaction is plausible. Thus, second, who is Paul Leroux? His Wikipedia page tells an amazing story. It starts:
Paul Calder Le Roux (born 24 December 1972) is a former programmer, former criminal cartel boss, and informant to the US Drug Enforcement Administration (DEA).

In 1999, he created E4M, a free and open-source disk encryption software program for Microsoft Windows, and is sometimes credited for open-source TrueCrypt, which is based on E4M's code, though he denies involvement with TrueCrypt.[4]

Le Roux was arrested on 26 September 2012 for conspiracy to import narcotics into the United States, and agreed to cooperate with authorities in exchange for a lesser sentence and immunity to any crimes he might admit to later. He subsequently admitted to arranging or participating in seven murders, carried out as part of an extensive illegal business empire.

Le Roux was sentenced to 25 years in prison in June 2020.
You can get some idea of his level of criminality from the fact that the "lesser sentence" was 25 years.

Cryptadamus' eloquent case that Le Roux is Nakamoto boils down to:
  • He was probably the author of TrueCrypt, an exceptionally fine program, so had the necessary cryptography and programming skills.
  • As the mastermind of a major international criminal enterprise he had a pressing need for "a censorship-resistant payment mechanism that operates outside the traditional financial system".
  • At the time of Le Roux's arrest, Nakamoto's stash of about 1M BTC was "worth" about $12.4M, not a significant amount for the mastermind of a major international criminal enterprise. Since his arrest, Le Roux couldn't access the stash, currently "worth" about $30B. This would explain why the stash has remained untouched.
If Cryptadamus is right, the prevalence of crime in cryptocurrencies was a feature, not a bug, from the very beginning of the Bitcoin era.


David. said...

Via Molly White we find Hamas’ Al-Qassam Brigades Announces End of Cryptocurrency Donation Efforts:

"For years, AQB has used cryptocurrency donations as a means to raise funds while circumventing the traditional financial system, from which the organization is largely cut off. AQB has historically set up websites and social media campaigns to solicit these donations, providing specific donation addresses for sympathetic readers and even providing detailed instructions on how to acquire and send cryptocurrency without alerting authorities.
Today, however, AQB’s official website displayed a new message announcing the end of its crypto donation efforts, citing successful government efforts to identify and prosecute donors."

David. said...

Whow would have thought that insider trading laws would apply to NFTs? Regulatory clarity emerges in Molly White's Former OpenSea executive convicted of fraud and money laundering in NFT insider trading case:

"Nate Chastain, the former Head of Product for the popular OpenSea NFT marketplace, was convicted by a jury of fraud and money laundering for illegally profiting from his insider knowledge of which NFTs would be featured on the site. The two charges each carry a maximum sentence of twenty years in prison."

Emily Nicolle explains that the NFT word exists on insider trading in NFT Crowd's ‘Alpha’ Just Might Put Them in Jail:

"In traditional finance, the term refers to the excess return on an investment relative to a benchmark. But for crypto investors, it means super-secret, early knowledge of the market’s next big thing — an asset which could earn them some serious cash. But now, the legality of that concept is getting put to the test in a courtroom.
Take a look at Twitter and on any given day: It’s full of accounts spreading so-called alpha about their favorite project and how it’s the one that’s going to succeed. Entire Discord servers and Telegram chat groups are dedicated to the idea, filled with eager buyers desperate to be among the first to benefit from crypto’s promised bull market return."

Fazal Majid said...

Crypto is also used for capital flight, which is illegal but not inherently immoral when it occurs in authoritarian countries like China or Venezuela. Of course, the public nature of the blockchain also makes those transactions traceable and exposes those responsible to government retortion if they haven't already escaped the country.

David. said...

In Binance Partner Advcash May Facilitate Transfers from Sanctioned Russian Banks Dirty Bubble Media reports on one way Binance is enabling sanctions evasion:

"While these findings do not definitively prove illegal activity, the services offered by Advcash certainly seem problematic in light of sanctions related to the current war in Ukraine. Based on the services advertised on their site, it seems possible that Advcash could be used to evade sanctions on Russian banks. For example, one could use a third party service (shared by Advcash) to move rubles from sanctioned Sberbank into an Advcash wallet. The customer could then purchase crypto on the Advcash site, using services provided through the Binance partnership, and then transfer that crypto to Binance or a different crypto exchange. By cashing back out to fiat currency, the customer could successfully avoid the Western blockade of the Russian financial system."

David. said...

From the not-your-keys-not-your-coins department comes Steven Church's BlockFi Crypto Customers Lose Fight Over Disputed Coin Transfers:

"BlockFi Inc. customers who tried to reclaim nearly $300 million in crypto after the company froze transfers last year don’t have a right to the digital assets, a judge ruled, handing potential losses to investors who held interest-bearing accounts.

US Bankruptcy Judge Michael Kaplan sided with the company and dismissed the objections of a group of customers, who argued they retained rights to the coins even before they were moved into a secure, digital wallet. Those who kept their assets in interest-bearing accounts gave up certain ownership rights, while those in custodial accounts did not."

David. said...

Chainalysis' blog post Crypto and the Opioid Crisis: What Blockchain Analysis Reveals About Global Fentanyl Sales concludes that:

"Due to recent law enforcement actions and sanctions, we know that many illicit actors involved in fentanyl-related transactions use cryptocurrency. To analyze these patterns at scale, Chainalysis identified cryptocurrency addresses associated with suspected China-based fentanyl precursor sellers. These addresses have received more than $37.8 million worth of cryptocurrency since 2018. Latin America, North America, Europe, and Asia exhibit a high degree of exposure to these suspected chemical shop addresses.

Using data from U.S. Customs and Border Protection, Chainalysis found that on-chain flows to suspected chemical shop addresses correlate with fentanyl seizures at the U.S.-Mexico border, suggesting that cryptocurrency-based transactions associated with fentanyl production match regional patterns previously identified by the DEA."

David. said...

Joel Rosenblatt reports on the closing off of another use case in Kraken Ordered to Turn Over Its Users’ Information to the IRS:

"The IRS “has a legitimate purpose for seeking the materials,” the judge wrote, namely to “determine the identity and correct federal income tax liability” for users in the designated time period.

The agency’s demands are backed up by the fact that taxpayers filing returns with Bitcoin-related investments are “dwarfed by the amount of trading activity that occurs on Kraken,” Spero said. The exchange had 4 million clients conducting more than $140 billion in trades from 2011 to 2017, and was registering as many as 50,000 new users daily, according to the order."

David. said...

More on the cryptocurrency use case from Joe Tidy in FTX thief cashes out millions during Bankman-Fried trial:

"A thief who stole more than $470m (£383m) in cryptocurrency when FTX crashed is trying to cash it out while the exchange's founder is on trial.
After lying dormant for nine months, experts say $20m of the stolen stash is being laundered into traditional money every day.

New analysis shows how the mystery thief is trying to hide their tracks.
The rest of the stolen FTX stash - around $230m - remained untouched until 30 September - the weekend before Mr Bankman-Fried's trial began.

Nearly every day since then chunks worth millions have been sent to a mixer for laundering and then presumably cashing out.

Elliptic has been able to trace $54m of Bitcoin being sent to the Sinbad mixer after which the trail has gone cold for now.
Some of the stolen Bitcoin successfully laundered last year has been traced to a wallet known to be used by Russian-linked criminal groups. Elliptic says this could point to the involvement of a broker or other intermediary with a link to Russia."

David. said...

Katrina Manson reports that North Korea Suspected in Massive Hack of DeFi Project Mixin:

"Mixin Network, which helps blockchains handle transactions more efficiently, said it had lost less than $150 million in a late-September attack. Originally the company estimated it lost $200 million but reduced it after a final inspection.

“The tradecraft appears to be the same kind of tradecraft we’ve seen from the DPRK previously,” Anne Neuberger, deputy national security adviser for cyber and emerging technology, told Bloomberg News in an interview"

David. said...

Crime may be the use case for Bitcoin, but as Matt Levine points out in Bitcoin Is Not Great for Murder it isn't that good at it:

"So if you send someone $16,000 worth of Bitcoin to buy a $16,000 thing, (1) some of your money will go missing in transit, (2) the Bitcoins you send won’t be worth $16,000 and you’ll have to send some more, and (3) the $16,000 thing was a murder and now you are in prison."

Levine recounts the story of James Wan, who tried to pay a hitman using Bitcoin and suffered all three of these problems.

Not content with that, Levine also recounts the story of Jimmy Zhong:

"who called 911 because someone stole his Bitcoins, and the cops showed up and were like “okay but who did you steal the Bitcoins from,” and he was like “oh Silk Road” and they arrested him. No, I’m kidding, I’m condensing the timeline, and he didn’t actually say that, but that is where he stole the Bitcoins from, and they did ultimately arrest him for it. The scorecard here is:

1. The guy who stole hundreds of thousands of dollars’ worth of Zhong’s Bitcoins was never caught.
2. Zhong was sentenced to a year in prison for stealing billions of dollars’ worth of Silk Road’s Bitcoins.
3. The guy who ran Silk Road was sentenced to life in prison, mostly for running a marketplace selling drugs for Bitcoins though also for trying to use Bitcoins to hire hitmen to do some murders."

David. said...

Joseph Cox's Inside a $30 Million Cash-for-Bitcoin Laundering Ring in the Heart of New York reports on the fiat off-ramp for cryptocurrency:

"For years, a gang operating in New York allegedly offered a cash-for-Bitcoin service that generated at least $30 million, with men standing on street corners with plastic shopping bags full of money, drive-by pickups, and hundreds of thousands of dollars laid out on tables, according to court records.

The records provide rare insight into an often unseen part of the criminal underworld: how hackers and drug traffickers convert their Bitcoin into cash outside of the online Bitcoin exchanges that ordinary people use. Rather than turning to sites like Coinbase, which often collaborate with and provide records to law enforcement if required, some criminals use underground, IRL Bitcoin exchanges like this gang which are allegedly criminal entities in their own right."

David. said...

In Bitcoin pioneer Hal Finney can’t be Satoshi Nakamoto, new analysis suggests Brayden Lindrea reports on Jameson Lopp's new analysis:

"Lopp’s key evidence revolves around a 10-mile race in Santa Barbara, California, on Saturday, April 18, 2009.

According to the race data, Finney competed in the “Santa Barbara Running Company Chardonnay 10 Miler & 5K,” starting at 8:00 am Pacific Standard Time and finishing the race 78 minutes later.

The race, however, coincides with timestamped emails between Satoshi and one of the first Bitcoin developers, Mike Hearn."

Lopp's blog post is an extremely good read.

David. said...

Famed short-seller Jim Chanos agrees with my post:

"You have to understand that the crypto ecosystem is well-suited for the dark side of finance for a lot of reasons. It’s perfect for facilitating money laundering and illicit transactions. But also, there’s the nature of the unregulated domiciles for a lot of this activity where someone can go to basically defraud customers, whether it’s NFTs or ICOs [Initial Coin Offerings] or all the various types of digital flimflammery out there – it’s perfect."